The U.S. Fed has broadcast its intention to raise interest rates three times in 2017. After March’s rate hike, barring any downdrafts in growth or inflation, we should expect two more Fed increases this year. At the same time, we are taking into account diverging monetary policy globally. In terms of the European Central Bank (ECB), we think that they're going to maintain quantitative easing (QE) at $60 billion for all of 2017. However, we do expect they will start talking about tapering. This could introduce a scenario where yields start backing up pretty quickly in Europe.
In Asia, the Bank of Japan seems to be looking to anchor yields at zero for much of 2017 – hoping that they can keep their currency weak. The central bank in China, the People’s Bank of China, appears to be tightening liquidity and trying to stem capital flight. So we've got some diverging policy going on, and it will be critical to see how that dominates market action throughout the year.
U.S. in late-cycle expansion
As we analyze credit cycles across the world, we believe the U.S. is in late-cycle expansion. However, the possibility of a fiscal stimulus that has been put on the table by the Trump presidency could extend the cycle slightly longer than we thought. So recession is not something that we're assessing as a big risk for 2017, or probably for much of 2018. We believe Europe is in recovery phase and Japan is moving out of credit repair into the recovery phase. Brazil and Colombia specifically, we think, have entered the credit repair phase of the cycle. Other emerging market countries such as Turkey are still in a downturn. Economies worldwide are at varying parts of the cycle.
Opportunity among dividend-paying global equities
One place that we're interested in for much of this year is global equities, and specifically in Japan. We think that Japanese equities could be an interesting source of income this year. They're benefiting from the weaker Japanese yen and corporate reform, and we think that many Japanese companies are increasingly becoming more shareholder-friendly.
Financials more attractive
We are currently positive on European and American financials, but would avoid emerging market banks and Asian banks, specifically Turkey, Mexico, Korea, and most of Asia. Back in the U.S., if the Trump administration does push through some deregulation, and if it were to reform the Dodd-Frank Act (legislation passed in 2010 to govern the financial industry) and repeal some labor regulations, that could all be beneficial to banks. Additionally, if we see increased manufacturing in the U.S., combined with regulatory reform, it could be pretty bullish for loan demand, which would help some of the regional banks as well.
Bank loans, Brazil, and energy
When we think about higher interest rates and higher inflation, it’s important to select fixed-income sources that are less rate-sensitive. Therefore, we believe the bank loan sector is more favorable. Also on the debt side, we are finding interesting yield opportunities in Brazil and Argentina in 2017. Both economies have gone through very deep recessions but now have new economic policies and appear to be starting to stabilize. We have seen some attractive yields in the low double digits. Another area where we are finding interesting sources of income is in energy-related MLPs (master limited partnerships) and energy-related high-yield bonds and dividends.
Overall, we believe having the flexibility to adapt to changing credit cycles and market environments will become more critical as we move through 2017. Also, volatility has been extremely low for several months now. However, it could reappear at any moment, especially given where we are in the economic cycle.
Maura Murphy is a Vice President and Portfolio Manager at Loomis, Sayles & Company.
She is a co-Portfolio Manager for Loomis Sayles’ Fixed-Income Group, and also manages multi-asset income, real return, global macro, and global interest rate & foreign exchange derivatives strategies. Maura is responsible for asset allocation decisions and optimizing portfolio construction. She joined the firm in 2003 as a quantitative analyst, before moving into a role as absolute return analyst and investment strategist. Maura earned a BA in mathematics from the College of the Holy Cross and an MBA from the Carroll School of Management at Boston College. She is a CFA® charterholder.